Disentangling Sources of High Frequency Market Microstructure Noise

Employing tick-by-tick maximum likelihood estimation on several leading models from the financial economics literature, we find that the market microstructure noise is mostly explained by a linear model where the trade direction, that is, whether the trade is buyer or seller initiated, is multiplied...

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Bibliographic Details
Published inJournal of business & economic statistics Vol. 39; no. 1; pp. 18 - 39
Main Authors Clinet, Simon, Potiron, Yoann
Format Journal Article
LanguageEnglish
Published Alexandria Taylor & Francis 2021
Taylor & Francis Ltd
Subjects
Efficient price
High frequency data
Market microstructure noise
Mid price
Noise
Trade direction
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Summary:Employing tick-by-tick maximum likelihood estimation on several leading models from the financial economics literature, we find that the market microstructure noise is mostly explained by a linear model where the trade direction, that is, whether the trade is buyer or seller initiated, is multiplied by the dynamic quoted bid-ask spread. Although reasonably stable intraday, this model manifests variability across days and stocks. Among different observable high frequency financial characteristics of the underlying stocks, this variability is best explained by the tick-to-spread ratio, implying that discreteness is the first residual source of noise. We determine the bid-ask bounce effect as the next source of noise.
ISSN:0735-0015
1537-2707
DOI:10.1080/07350015.2019.1617158